It is time to think about your tax returns and preparing for tax season. Part of that is making sure you have taken advantage of all your legal options for reducing your taxes. Most of us are fairly limited in terms of deductions. Some of us have kids, some of us have a mortgage, some of us have property taxes and some of us have a mix. Unfortunately, these all live below the line and one of the best places to save is “above the line”.
Above-the-line adjustments, are not deductions, even though they are popularly referred to as above-the-line deductions because you subtract them on Page 1 of your 1040, just above the page’s last line (number 37 on the 2005 return) where you enter your adjusted gross income, or AGI. Using these deductions will reduce your AGI, which in most cases directly reduces your tax liability. Obviously, the more you can reduce your taxable income the less the IRS has to tax. Here are this tax season’s above-the-line deductions, in the order they’re found on Form 1040 (lines 23 through 36).
1. Archer MSA deduction. Requires form 8853. Click 8853 instructions for directions on how to fill out this form. It allows someone to make contributions and have the interest grow tax deferred. Distributions are then made to pay for medical expenses. You are able to take a deduction for contributions made to an MSA account similiar to receiving a deduction on contributions made to a 401(k). A good description can be found here.
2. Certain business expenses of reservists, performing artists, and fee-basis government officials. Requires forms 2106 or 2106-EZ. Many people deduct business expenses as a miscellanous itemized deduction that must exceed 2% of your AGI to count. However, if you meet specific requirements for this deduction you can end up with a larger tax break. Go here for a detailed break out of this deduction.
3. Health savings account deduction. A health savings account, or HSA, is a medical coverage plan that works much like an IRA. Eligible participants put money into an HSA where it grows tax free and withdrawals can be made to pay medical, dental and vision-care costs not covered under a corresponding high-deductible health-care policy. HSA holders can deduct, within IRS limits, their annual contributions; for 2005 tax purposes, that includes money contributed last year, as well as deposits to the account as late as this April 17. The maximum possible above-the-line HSA deduction on 2005 returns is $2,650 ($5,120 if the account is for family coverage). Fill out Form 8889 to determine the exact amount you can claim here.
4. Moving expenses. If you relocated for job reasons, some of your expenses can be deducted here. You will, however, also have to fill out Form 3903./p>
5. Self-employment tax. If you’re self-employed, you have to pay Social Security and Medicare taxes — both the amount collected from you as an employee and you as an employer. But you get to deduct half of those payments here.
6. Self-employed retirement plans. If you have a self-employment pension plan, such as a Keogh or a SEP-IRA, deduct any contribution amounts here.
7. Self-employed health insurance. As an entrepreneur, you now can deduct 100 percent of health insurance premiums you paid for yourself, your spouse and dependents. Don’t forget to count what you paid toward long-term care policies. You get a partial break here, too.
8. Penalty on early withdrawal of savings. On this line, the IRS gives you a break when someone else slaps your hand! If you cashed in a certificate of deposit and paid an early-withdrawal penalty, you’ll find the amount on the 1099-INT or 1099-OID that the account manager has sent you. The IRS lets you subtract that charge from your income.
9. Alimony paid. Divorced filers get a chance to recoup alimony payments here. Be sure to include the Social Security number of your ex-spouse, so the IRS can make sure he or she reports the payments as income. Without the recipient’s tax ID number on your return, the deduction could be disallowed.
10. IRA deduction. If your company doesn’t offer a retirement plan, you might be eligible to contribute up to $4,000 for the 2005 tax year to a traditional individual retirement account and subtract that full amount from your income. The amount goes to $4,500 if you’re 50 or older. Even if you have a company pension plan or 401(k), the Internal Revenue Service has increased the earnings limits — as much as $79,999 on a joint return for a worker with a pension; $59,999 for single filers — so that more people are able to take at least a portion of this tax break. An IRA deduction work sheet is included in the Form 1040 instructions, which will also help joint filers figure an allowable deduction where only one spouse is covered by a pension at work.
11. Student loan interest. Up to $2,500 of the interest you paid on a qualified student loan can be subtracted here. The loan can be for you, your spouse or a dependent. You are no longer limited to deducting interest paid during the first 60 months of the loan, making longer-term college loans more tax valuable. However, this deduction is limited if you make $65,000 and are a single filer, $135,000 or more and file jointly with your spouse. Married taxpayers who file separate returns cannot claim this adjustment.
12. Tuition and fees deduction. If you’re eligible to claim this deduction, you could reduce your taxable income by up to $4,000 ($1,000 more than last year’s deduction). There are income limits on who can claim this tax break, and remember that it is for tuition and fees, not room and board or other educational expenses, that you paid for yourself, your spouse or a dependent.
When planning your goals for 2009 knowing how much you can save is just as important as how much you want to save. If you are able to take advantage of the full limit of different programs, it is useful to know what the limits are currently. I wish you the best of luck with your goals and a very prosperous new year.
401(k) Limit
Health Savings Account ( HSA ) Limit
Traditional and Roth IRA Limit
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